An F-35 jet sits on the tarmac at its new operational base Wednesday, Sept. 2, 2015, at Hill Air Force Base, in northern Utah. A major independent study of federal government contract pricing and policies has warned that the current system provides "perverse incentives" for industry doing business with Ottawa to hike their costs, particularly in military equipment deals.

Image Credit: THE CANADIAN PRESS/AP/Rick Bowmer

March 14, 2016 - 6:00 AM

OTTAWA - A major independent study of federal government contract pricing and policies has warned that the current system provides "perverse incentives" for industry doing business with Ottawa to hike their costs, particularly in military equipment deals.

The report written by the research firm PricewaterhouseCoopers — a copy of which was leaked to The Canadian Press — also says that both Public Services and Procurement and National Defence don't have the in-house staff and expertise to understand technical matters that contribute to higher project costs.

The 32-page draft study, dated Nov. 17, 2015, was ordered by the former Conservative government, but delivered to the Trudeau Liberals, who promised in last fall's election to fix the broken procurement system to ensure the military gets the equipment it needs.

The eye-popping cost of ships, planes, and tanks has been the subject of a political debate, notably over the F-35 stealth fighter, but also more recently with the navy's planned frigate replacements.

Researchers at the multi-national audit firm were asked to examine how government policies, procedures and legislation contributed to the enormous price tags.

One of the key findings was that the structure of the contracting regime "provides perverse incentives for industry to increase costs" — particularly in sole-source deals — and there is "limited expertise in government" to review industrial processes and validate the increases.

"Neither (procurement services) nor DND has a sufficient knowledge base of subject matter experts that understand the 'Should-Cost' of a project, nor does either have the ability to understand the production process or other technical matters which are important drivers of cost and risk," said the study, which compared Canada's system with Britain, Australia and the U.S.

The report notes that there is a particular shortage of "military industrial specialists" and this "constrains Canada's ability to validate the reasonableness" of the costs claimed by contractors.

It warns that the country's global competitiveness in the defence sector is at risk, and that companies actually benefit by jacking up their prices.

"Profit is proportionate to cost under most of the basis of payment options — if the profit percentage is fixed, increased costs result increased profits," said the report, which added the government "does not have mechanism to counteract these perverse incentives."

The findings are significant because billions of dollars are about to be spent on the national shipbuilding program. The previous Conservative government set up a special relationship with two of the country's shipyards — Seaspan in Vancouver and Halifax-based Irving Shipbuilding Inc.

In exchange for directing federal contracts exclusively to both companies, procurement services pledged there would be strict oversight to ensure that taxpayers were not being overcharged.

Public Services and Procurement Canada did not respond to a request for comment.

Dave Perry, an analyst from the Canadian Global Affairs Institute, has studied military procurement woes from the defence department's perspective and found much the same.

He says the new report further "highlights the human capacity shortfall" of a system that was "gutted during program review in the 1990s and never recovered."

Perry and fellow defence analyst George Petrolekas, a retired colonel, wrote a groundbreaking report for the Conference of Defence Association Institute and the MacDonald-Laurier Institute in January 2015 that concluded, among other things, that brain drain and red-tape were responsible for the dysfunctional procurement system at National Defence.

Whereas the PricewaterhouseCoopers report looks at projects looks after they're launched, Perry and Petrolekas focused on the front-end planning at defence that's required on complex military equipment deals.

They assigned much of the blame to staffing cuts by both Liberal and Conservative governments in the acquisitions branch at National Defence.

In the early 1990s, there were 9,000 staff dedicated to buying military equipment. There were just over 4,300 by 2009 and those people were responsible for pushing through double the number of projects.

"Set against this significantly increased workload, there is simply not enough capacity in the acquisition workforce to manage it,'' said assessment by Perry and Petrolekas.

The Liberals, with both reports in hand, have an opportunity to start fresh, said Perry.

"We should move to treat defence procurement as its own specialty within government, and staff it accordingly," he said.

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